Factoring for cash
Factoring for cash

Invoice factoring is an often-overlooked financing option for most small businesses. Factoring isn’t a loan or an automatic sale of future revenue, like a business cash advance. Factoring is the sale and assignment of your unpaid invoices to a third party factoring company- you turn over the right to collect on an invoice or account, and the factor cuts you a check. Many businesses use factoring services as a method of outsourcing collections, or as a way to mitigate the damages of uncollectible invoices. If you have overdue customer accounts, unpaid invoices, or sell to customers on credit, you’re eligible for factoring.

One of the best-kept secrets in factoring is that most companies are willing to negotiate with you. Many companies actually make money using factoring transactions to generate operating capital. If you know what to ask for, you can get a great deal. Here’s how:

Factoring: The Basics

The factoring process itself is relatively straightforward. First, you collect the invoices that you want to “sell” and apply for an account with the factor. The factoring business reviews the invoices, and checks for client creditworthiness and payment history. If the factoring company wants to purchase your invoices, they make you an offer: you get an advance amount up front, or a percentage of the invoice value, upon assignment of the invoice to the factor. Once the customer makes payment, you get the rest of the invoice amount, less a factoring fee.

Costs: How to Get a Better Deal

Most factoring fees also known as discount rates are somewhere between 3% and 5% of the invoice value. Obviously, the lower the fee, the better the deal. You can avoid high rates in a few ways:

  • Use Non-progressive Billing: Factors prefer the least labor-intensive transactions. Progressive billing- where a customer is billed on an ongoing basis for ongoing orders- makes it difficult for factors to calculate owed amounts and payments. If you factor non-progressive bills only (those where an order was placed and delivered, and you’re just awaiting payment) you’ll get a better deal.
  • Factor Largest Invoices Only: Factoring companies look for the most profitable transactions, which tend to be large single invoices, rather than a customer account that includes several smaller ones.
  • Creditworthy Customers: The single most important consideration to a factoring company is the creditworthiness of the companies that owe you money. Reputable companies equal better rates.

What to Ask For

Factoring contracts are complex- factoring businesses try to implement a variety of provisions to ensure that they are paid back, either from your customer or from your business. Here are a few things you can ask for that will make the transaction easier (and potentially less costly) on your end:

  • Recourse and Non-Recourse Factoring: Recourse factoring is less expensive, but risky: if the factor does not receive payments from your clients, you are responsible for the owed amounts. These can often be automatically deducted from your bank or merchant account, similar to a merchant cash advance. Non-recourse factoring eliminates the risk to your business, but tends to be more expensive. If you have unreliable clients, the non-recourse route is probably less expensive in the long run.
  • Open Contracts: Most factoring companies have some kind of “setup” cost that you’ll pay when you initiate the transaction. If you have multiple invoices you that you want to sell, you can pay a one-time service (“setup”) fee, or pay a bit more for an “open” contract. An open contract allows you to send more invoices to the factor in the future without the need for additional account setup costs with each transaction.
  • Renegotiable Terms: Most factoring companies are willing to work with you on the specifics of an agreement- you can usually negotiate a lower factoring fee, a higher advance amount, or a discounted setup cost if you ask.

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